Four Common LIHTC Compliance Pitfalls and How to Avoid Them
We at Novogradac are regularly engaged by developers and property managers of low-income housing tax credit- (LIHTC-)financed properties, and their investors, to review tenant files. From this vantage point, we witness the high degree of property compliance across properties.
That said, we have identified some property compliance pitfalls or categories of pitfalls that we see across a subset of LIHTC properties. These compliance pitfalls–or, rather, examples of LIHTC noncompliance–can (but don’t necessarily) lead to financial loss through reductions of current and future credits, as well as recapture of previously claimed credits.
Financial loss can often be avoided if the noncompliance is corrected within a reasonable period from when it was or should have been identified. We emphasize “should have been” identified to stress the importance of having systems in place to avoid noncompliance, but secondarily, and quite importantly, quickly identify any instances of noncompliance. Documenting those systems can lessen the potential for a state agency to determine that an owner or property manager failed to take corrective action within a reasonable time from when noncompliance should have been discovered.
This column doesn’t have sufficient space to review all LIHTC compliance pitfalls, but will discuss four that are most common. They are:
- miscalculating household income,
- inadequately verifying tenant income and assets,
- incorrectly managing consequences of tenant transfers, and
- improperly calculating utility allowances.
With an eye on avoiding noncompliance, we will also review corresponding action steps to avoid them.
1. Miscalculating household income
The most common cause of noncompliance is a failure to properly determine household income. The calculation of household income has three central components: who makes up the household, their sources of income and the projected income on assets they hold.
The most common error in determining household makeup is a failure to properly account for future residents during initial screening. Tenants are required to declare whether any future residents are expected, allowing the property manager to include them in initial screening. Sometimes, tenants will fail to answer this question on tenant questionnaires and property managers fail to follow up. The result is the omission of the income of the future resident, which can mean the household is over-income.
A related error is failing to properly screen additional residents who join the household after initial screening. New residents must be fully screened to determine continuing household eligibility.
Sources of Income
In determining household income, a common error is incorrectly assuming an adult student is a dependent. Consider the case where a 20-year-old child of the head of household is a full-time college student who is also employed. Employment income must be included as household income. However, as a dependent, only the first $480 of their employment income is counted as household income–which rarely would affect household income eligibility. But incorrectly assuming dependent status would mean failing to include the additional income by the student, which could mean the household is over-income.
Another error calculating household income involves the incorrect calculation of child support payments–particularly when the tenant receives less than a court-ordered amount. Child support, child support arrears and retroactive child support are all included in household income. In order to include in household income an amount of child support less than the court-ordered amount, a tenant needs to satisfy two requirements:
- they must certify that the full payments are not being received, and
- they must document that all reasonable legal actions to collect the full amounts have been made.
Failure to do either of those means the income cannot be excluded. Including the lesser amount without meeting both standards can cause noncompliance.
A third common mistake is to misapply state community- or separate-property laws. For instance, Texas isn’t a community-property state, so a Texas tenant who is a separated spouse isn’t entitled to any of their spouse’s income. As such, a separated spouse’s household income generally doesn’t include any of their spouse’s income. Conversely, California is a community-property state and a separated spouse generally is entitled to a share of their spouse’s income and vice versa. As such, a separated spouse’s household income may need to consider their share of their spouse’s income.
Imputed Income on Assets
A common error in determining asset income involves property managers failing to recognize income from certain assets when that income is reinvested. Reinvested interest or dividend income is still income and must be recognized as such to avoid potential noncompliance.
Action step: Make sure your tenant application reflects the requirements for your state, then bring in outside professional help to review your application and household-income-calculation systems. Have a tenant file inspection before the end of the first year of your credit period.
2. Inadequately Verifying Tenant Income and Assets
Property managers must verify reported household income and the most common error is failing to follow the state’s verification standards.
Verification standards are determined at the state level. For instance, one state may require a third-party verification of employment income along with three months of pay stubs, while another may require an attempt at third-party verification and pay stubs and a third state may simply require that the employment be verified, allowing the use of either third-party verification or pay stubs. Failing to follow your state’s specific verification requirements is a compliance error, which could also lead to incorrect household income calculations.
Action step: Create a checklist of verification steps for your state(s) and have that reviewed by an expert. Also, provide a system to ensure that the correct steps are followed. Bring in an outsider to review verifications and catch oversights.
3. Incorrectly Managing Consequences of Tenant Transfers
Tenants transferring between units can create surprising compliance issues, issues of which many property managers are unaware.
To understand the issues requires a look at the swap rule for LIHTC housing, which provides that when a tenant moves from their unit to another unit, the units swap status. This rule generally applies on a building-by-building basis unless the property owner has chosen to apply the rule on a project-wide basis.
For mixed-income LIHTC projects, the swap rule means that when an income-qualified LIHTC tenant moves from a LIHTC unit to a market-rate unit in the same building, the units swap status–with the former market-rate unit becoming a LIHTC unit and vice versa. The problem comes when the unit into which the low-income tenant moved is smaller than the previous unit, which can reduce the qualified basis on which the LIHTC is claimed for the building. While not technically a noncompliance matter, credit loss and recapture could result.
A related issue is when a LIHTC tenant in one building moves into a market-rate unit in another building in the same mixed-income project. In that scenario, the low-income occupancy percentage for each building changes, which could reduce the LIHTCs.
A third error comes when a tenant moves to another building within the same property when property compliance is not determined on a project-wide basis. Rather, the second building was declared a separate project on IRS Form 8609. In this scenario, property managers might assume the tenant is automatically qualified as a low-income household for the new building when they’re not: when moving from project to project, tenants must be certified each time and failure to do so results in noncompliance.
A fourth error in tenant transfer arises when a tenant’s income has reached 140% or more of the income limits for the property and moves to a new unit in a different building in the same mixed-income project. Such a tenant may remain in their current unit, but is ineligible for another LIHTC unit–and allowing that transfer makes the new unit noncompliant.
Action step: Recognize the consequences of tenant transfers and bring in outside help to best manage them. Consider your options at the outset: when the Line 8b election must be made on IRS Form 8609 to determine the makeup of a project, consult with an expert on your options and the repercussions. Once the election is made, review it regularly when considering transfers and new tenants.
4. Improperly Calculating Utility Allowances
Failure to conduct annual reviews or correctly implement updated utility allowances will create noncompliance–and there are two common errors that create that scenario.
The first is when properties using the public housing authority (PHA) method for utility allowances fail to implement a new allowance within the allotted time. Properties generally have 90 days to implement an updated PHA allowance (which often requires a rent adjustment), so a failure to check in regularly with the PHA can cause a failure to meet the deadline.
The other common error occurs when properties that use one of the other four utility allowance methods fail to conduct an annual review or fail to implement an updated allowance. An annual review is required and both the state and tenants must be notified of the changes and be allowed to comment. Failure to either conduct the review or implement the updated allowance creates noncompliance.
Action step: If you use the PHA method, ensure that you are checking in regularly with the PHA and documenting those efforts (with a phone call log or with dated pdfs to prove you reviewed the website). If you use one of the other methods, have a timeline and follow it. In both cases, bring in outside professional assistance to choose the right method and ensure you are implementing it correctly.
Training, Backup Critical
Before closing, here are some additional, overarching compliance action steps:
- Property owners should consider mandatory training at their properties, with a focus on the type of property involved (a senior property, for instance, may have different challenges than a family property in the same state). LIHTC compliance trainings can be intimidating, as they are all-encompassing and may not empower staff in the way most needed. The best training sessions focus on what your staff needs to know to be successful. Novogradac’s private training sessions provide hands-on assistance. These sessions can be recorded, providing ongoing access to training materials for period of time, which allows existing staff to review and newcomers the tools they need to succeed.
- As noted in the action steps, having a second (or third) set of eyes is critical. This may be a simple as bringing in someone six months ahead of a state inspection to conduct a full review of tenant files (to identify issues for both the state and federal levels). Another option is to regularly have an outsider conduct a sampling test of tenant files during the three-year period between inspections.
- Consider having occupancy reviews done both in real time and in review. This is the best way to catch errors early–particularly in the first year, when properties have the largest number of new tenants. Real-time reviews of applications can prevent significant difficulties down the road.
As said earlier, the percentage of LIHTC properties that are in full compliance is extremely high–and a robust property compliance system is crucial to avoiding noncompliance. Being aware of pitfalls, conducting ongoing training, creating systems and correcting errors as quickly and thoroughly as possible can help avoid the headaches and financial penalties that can come with noncompliance.